Stock market on July 11, 2017: thoughts and outlook


*These are our short term discretionary thoughts on the market.  We’re looking at how the market reacts to news, earnings, and other fundamental themes. Our models determine our trades.
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Stock index & news

Topics discussed:

  1. Donald Trump Jr, healthcare reform, and this “small rally” in the S&P 500
  2. A closer look at Q2 2017 earnings season.
  3. U.S. debt levels aren’t excessive.
  4. Europe’s economy is growing decently. Where’s the slowdown?

Today’s news
The S&P’s current “small rally” is one of the longest in history. When a rally becomes this aged, anything can bring it down. To be clear, the news that “brings the S&P down” isn’t the real bearish factor – it’s merely the excuse for selling.

  1. The “S&P fell today because of political worries” argument is incorrect. The Donald Trump Jr news was merely an excuse for the S&P’s selloff.
  2. Previously, the stock market did not care about Trump-Russia news at all.

It’s hard for Trump-Russia news to bring the S&P down into a 6%+ “small correction” right now. Investors hate uncertainty, and the worst is out. Donald Trump Jr came clean and released his email correspondence with Russian government attorney Natalia Veselnitskaya. With the worst already in the open, it’s hard for the stock market to fall on this specific topic. As we learn more about the Trump campaign’s involvement with Russia, political uncertainty is shrinking.
Senate Majority leader Mitch McConnell announced that he would delay Congress’ summer recess to pass healthcare reform. This is highly unusual, and demonstrates that McConnell is doing everything he can.
The S&P hasn’t been rallying over the past few months because “investors expect healthcare reform to pass”. Investors know that the odds of healthcare reform passing Congress are <50%. So any reform that is passed will be additional icing on the cake.
Even if Trump can’t pass healthcare reform or tax cuts, he can still pass some infrastructure spending programs (although less than he would have liked). The Democrats are willing to work with him on infrastructure spending, which can be done via public-private partnerships.
Q2 2017 earnings season
Year-over-year earnings growth in Q2 2017 will be less than earnings growth in Q1 2017. This is normal. Q1 2016 saw terrible earnings, so Q1 2017 had an easy year-over-year comparison.
The key to earnings season is whether earnings reports “beat/miss” analysts’ expectations. Earnings reports tend to beat expectations because analysts purposely lower their expectations by 3-4%, setting up for an easy “beat”.

Corporate America’s debt isn’t too high
Every day you read one of those “debt levels are rising! Debt is too high!” headlines. The nominal value of debt means nothing. Over the long run, debt will forever go higher because the economy is growing! $100 today is equivalent to $10 fifty years ago.
Instead, focus on debt as a percentage of the economy. Debt levels aren’t ridiculously high today, especially in Corporate America.

  1. The S&P 500’s debt-to-market cap is 80% today. The average since 1980 is 82%. We haven’t even reached the average yet!
  2. Interest payment-to-corporate profits is more important. Today, this percentage stands at 11%. The average since 1980 is 13%!

Debt levels shouldn’t concern U.S. stock market investors right now. Debt will be a concern in 2-3 years IF interest rates rise significantly. That’s part of the reason why our medium-long term model states that this economic expansion has 2-3 years left.
Europe’s economic growth is on track.
Yesterday, a Citi analyst said “a slowdown in Europe’s economy could cause a correction in the U.S. stock market”.

  1. Historically, the correlation between Europe’s economy and the U.S. stock market is almost non-existent. Europe’s economy almost dipped into a recession in 2012. The U.S. stock market went up. The U.S. stock market is driven by the U.S. economy.
  2. Even if the Citi analyst is right, where is “Europe’s slowdown”?

Germany is Europe’s economic engine. Germany’s best leading indicator is the Ifo Business Climate Index. As you can see in the following chart, the Ifo Index is making new highs! And this is a leading indicator for Germany’s economy!

Germany’s economy is driven by manufacturing. German manufacturing is experiencing solid growth across-the-board.
Germany New Orders has been trending higher since 2013.

Germany’s manufacturing PMI is making new highs.

Germany’s Industrial Production growth is rising.

Bottom line

Nothing has changed since our our July 10 bottom line.

  1. Our medium-long term model says that the U.S. stock market is still in a “big rally within a bull market”. There is no significant correction or bear market on the horizon. The optimal investment decision is to follow our medium-long term model and be 100% long stocks.
  2. We are sitting on 100% cash. Based on our Easy Trading model, the most risk-free and guaranteed part of the current “small rally” is over.
  3. We’re waiting for the next 6%+ small correction. Then we’ll shift into 100% long UPRO (3x S&P 500 ETF).

Sectors

Sector rotation is strong (again).

  1. Tech up.
  2. Energy up (because oil is up).
  3. Finance down (interest rates are down).

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